Time to get serious, Sirius
The music will stop unless management gets into the used car business.
By Richard Saintvilus
The more things change, the more they remain the same. Although Sirius XM (SIRI) has done well this year, defying the odds and growing free-cash-flow (FCF) in the face of cheaper alternatives, like Pandora (P), there are still concerns about its business model, particularly what the company must do to maintain its strong profit margins, while also growing revenue.
When it comes to Sirius' business model, there has always been doubt. Truth be told, under former CEO Mel Karmazin, who sold 40 percent of the company to Liberty Media (LMCA) in exchange for a bag of beans, I never believed Sirius would have lived to see this day, much less questioning its FCF growth rate.
Even under new management, questioning the sustainability of Sirius growth will never get boring. Sirius, which relies predominantly on new car sales for its subscription revenue and profits, has benefited greatly from a strong rise in auto sales. Now with experts predicting that new car sales will advance close to 16 million units this year, it's hard to envision a meaningful year-over-year improvement rate, especially given that shares of Sirius have already soared more than 30 percent on the year.
The healthy rise in vehicle sales has not been lost on Apple (AAPL) and Google (GOOG), which have just entered the audio streaming fray with iTunes Radio and All Access, respectively. In fact, looking to prevail in the auto with its iOS platform, Apple has already signed agreements with some of the world's top automakers, including Jaguar, Mercedes-Benz (DAI), Chevrolet (GM), Honda(HMC), Volvo and Nissan (NSANY).
But unlike Sirius, which does have the advantage offering, for instance, non-music content like sports and talk radio, Apple is looking to offset this weakness with features that allow drivers to (among other things) receive iMessages, make phone calls and display Apple Maps. Not only that, but drivers will be able to execute these functions via Siri's voice command.
From the standpoint of safety, which is a benefit of eye-free controls, neither Sirius nor Pandora can match Apple. To that end, even as shares of Sirius sit at their 52-week high, bears are once again lining up to dig Sirius' grave. But I don't believe it's time to drop the curtains on Sirius just yet. This is regardless of any traction that Apple may gain in 2014.
Largely unsuccessful to this point, the used-car market can still be a viable opportunity for Sirius XM. Although management has devoted considerable resources to grow this business, they have been unable to put together the right formula. Even so, I don't believe Sirius management can afford to give up, especially with the used-car market expected to triple new vehicle sales.
This means that although Apple and to a lesser extent, Pandora, can pressure Sirius' stronghold in new vehicle sales, Sirius can still capitalize on a used-car market where sales are projected to grow close to 50 million. The fact is, while Sirius is growing subscribers in a year-over-year basis, investors gloss over the fact that, on a percentage basis, that the company's annual subscriber growth rate, which is now at 6 percent, has come to a crawl.
While 6 percent is still a respectable figure, it pales in comparison to another subscription service like Netflix (NFLX), which is growing at an annual rate of 22 percent and with which Sirius is often compared. Pandora's popularity, which continues to grow even amid Apple's entry, has had a lot to do with Sirius' recent lack of momentum. But Sirius management must now address concerns about future subscriber and margin growth with better marketing of its used-car initiative.
If Sirius is indeed serious about expanding margins to 40 percent it must drive the used-car market. Because not unlike new autos, there's anywhere between 20 million to 30 million used cars on the road with inactive radios that cost the company nothing to switch on. On Thursday, when Sirius reports its third-quarter earnings results, I believe this topic will be more critical than anything management will discuss about the company's future.
What's more, with the stock now trading at 45 times 2013 estimates and 34 times 2014 estimates, these shares are expensive by every meaningful standard. And I don't believe they are worth 6 percent annual subscriber growth rate, for which investors are willing to pay today. Sirius has had -- without a doubt -- a great year. But unless management gets deep into the used-car business, the music will stop.
At the time of publication, the author was long AAPL.
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